Business Lending: Five C’s of Credit

I’ve been a fan of Dr. Terry Noel, PH.D, and business professor for many years. He was first referred to me for credit card processing for sales of his (then) new book, Empty Nest Egg. After meeting him and reading his book, we would run into one another at the local coffee shop often enough that he must have wondered if I was stalking him. He’s an incredibly gifted orator and writer with a commitment to assisting entrepreneurs. He founded the Central Illinois Entrepreneurs Meetup Group in 2009 and for years I’ve intended to come and participate. Finally last week I made it a priority to attend my first meeting, in no small part because of the guest speaker and the intriguing topic.

Steve Timmermann, Vice President of First Farmers State Bank is a well known and respected banker in the community and I was very interested in hearing him speak first hand from a local bankers perspective on the topic of the Five C’s of Credit pertaining to business lending. I wasn’t disappointed as Steve was not only knowledgeable, but also a very engaging speaker. I must admit that he had me personally in the palm of his hand when he so enthusiastically endorsed Cornerstone during the introductions! My head swelled with pride, I furiously took notes as he spoke on business lending and I’m excited about passing on some of the finer points.

The first thing that Mr. Timmermann said was that the bank admires those business people that are willing to take a risk and they WANT to be a resource for their business capital needs.

Of course the banks do have criteria for business lending approval and it’s based upon The Five C’s of Credit: Character, Capacity, Capital, Collateral and Conditions.

Character – Since it’s unlikely that the banker personally knows you, they will rely on your credit report. The bank might not run the business credit report, but will always utilize a personal credit report. Other than perhaps doing something that makes headlines, this is what the character will be judged upon. A bank will generally want to see a fico score at a bare minimum of 600, but it can vary depending on the situation.

Capacity – This is all about the ability to pay the loan back. A few of the areas they will look at is the cash flow of the business as well as the debt to income ratio and other key financials, but they will take into consideration the overall big picture of the business. This area carries the most weight in the evaluation.

Capital – The personal investment the business owner has invested in his business and his equity in the business is important in judging the risk of a business loan.

Collateral – Another consideration is whatever the business might put up as collateral, such as property. The bank will weigh the collateral much differently than the owner, when it comes to real estate, inventory, receivables and equipment. This is due to the fact that the bank can’t hold on to the collateral and is often forced to ‘dump’ it at a loss.

Conditions – This factor takes into account all of the variables of the business and market conditions. It also encompasses the loan rate and amount.

All five of these items will factor into an evaluation where a bank will then score the business with a risk grade of 1-6. One is the lowest risk and an ideal loan for a lending institution, while a six indicates a loss.

“Why is money tight? That’s a myth. Banks have more money to lend than ever. The problem is finding good loans. The good risk loans are the loans banks fight over.” says Steve Timmermann.

So obviously the banks all want to lend to a risk grade of a 1, correct? Well, there are exceptions. I was surprised to learn that even if a potential borrower has great credit and is considered a low risk he could still be turned down if he doesn’t fit a particular lending institution’s profile. In that case it might be wise to pursue the loan with a different lender.

In order to evaluate a business’s credit risk score using the 5 C’s they will ask for documentation beyond just pulling a credit bureau report. Generally, a business can expect to be asked to provide a business plan, three years tax returns and a personal financial statement. With this balance sheet they will be looking at an honest net worth and then judging the borrower’s character based upon this. After this is all provided, approval and funding of the loan can be as quick as a couple days and as long as months.

Unfortunately, it was beyond the scope of the meeting and there were time constraints that prohibited us from discussing what happens when a traditional loan isn’t an option. Not everyone qualifies for a bank loan or has the time and/or documentation required. For existing businesses that can show a solid cash flow, Cornerstone has been very successful in quickly providing capital needs for growth.

For these non-traditional loans, they are generally considered riskier so the terms aren’t as accommodating as a typical bank/credit union loan. The advantage is that the only consideration for approval is the second ‘C’, in Capacity. This means a quick approval based upon limited documentation, showing only the ability to repay the loan.

I was impressed with Steve’s knowledge and I wouldn’t hesitate to recommend seeking him for a business loan or any other banking needs. I think for a business that is looking for capital for starting up or growth, a locally owned bank or credit union is the best place to go to first. You’ll have the relationship as well as extremely competitive terms. In the event that such a lending institution is unable to qualify a borrower, then other options are available to existing businesses through the Cornerstone Capital Advance program.

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[…] From a bank loan. An SBA loan or a line of credit for the amount needed is what I would recommend as the first source, as it will offer the lowest interest rate. The reality is that in this business environment, business loans aren’t always easy to get approved for. Also, it’s often a lengthy, cumbersome process that also shows up on their credit bureau reports and often ties up personal lines of credit as well. (more) […]

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